Meltdown

Well before the Dow’s wild swings captured the headlines, The Nation, like an early alert warning system, identified the dynamics that would prove so disastrous, using history as a guide and refusing to accede to the “Don’t Worry, Be Happy” conventional wisdom. Indeed, flipping back through the pages of the magazine in preceding years, one can track the policy decisions and economic trends that led to the crisis we are facing today. During the heady days of 1999, for example, the magazine editorialized in “Breaking Glass-Steagall” against the “grossly misnamed ‘Financial Services Modernization Act,’” which would remove the Depression-era wall between commercial and investment banks and thus pave the way for “future taxpayer bailouts of too-big-to-fail financial institutions.” As far back as 1990, Robert Sherrill discerned in the S&L crisis the early signs that something similar might be in store for the banking sector. At that time, Sherrill noted, the chorus calling for deregulation was recklessly demanding the repeal of laws that “protect the banking sector from its worst instincts by insisting that the banks remain banks, and not become gamblers, hucksters and hustlers in other lines as well.”

Unfortunately, the bipartisan backers of the deregulatory agenda won out, and banks went on to devise virtually any risky scheme that struck their fancy, shielded from the unwanted gaze of federal regulators. Wall Street’s speculative fever culminated in the frenzied trading of toxic mortgage-backed securities in the early 2000s, which allowed investors to get rich off an unsustainable bubble in the housing market. When real estate went south, the house of cards collapsed.

Quite naturally, the architects of this financial disaster would prefer not to get into the question of responsibility; they just want to talk solutions—foxes and henhouses be damned. As this volume went to press, Lawrence Summers, who as Treasury secretary under President Bill Clinton abetted the deregulatory agenda, was on the shortlist for the same post in the Obama administration. But history matters. As we try to find a way out of this mess, shouldn’t we listen to the voices that warned of the perils of deregulation; that pointed out there was something seriously awry in the industry of predatory lending; and that saw how rising inequality posed a threat to the health of the whole economy?

As things fell apart in 2008, these voices of reason reasserted themselves. Proposals to tax speculative financial transactions, rein in executive pay and crack down on exploitative lenders—proposals that had languished for years—suddenly gained traction. “Responsible” people in Washington were openly contemplating the partial nationalization of banks; Wall Street executives were forced to answer tough questions—and even repent for certain actions—before Congressional hearings; and a large-scale stimulus package that would advance the transition to a green economy went from top of the wish list of liberal think-thanks to top of the incoming administration’s agenda. A lame-duck President Bush even felt compelled to offer a defense of the system of free-market capitalism, as he shoveled taxpayer cash out the door as fast as he could to bail out the people he once called his “base,” the rich.

This collection, compiled from articles published in the magazine and on thenation.com, proceeds from the roots of crisis through its early stages to its alarming escalation, and it concludes with a series of pieces that tackle that age-old question, What is to be done? As none other than Milton Friedman, the father of free-market fundamentalism, once wrote, “Only a crisis—actual or perceived—produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around.” Friedman was right that ideas are important, but actions depend even more on who controls the levers of power, which segments of society they represent and what kind of pressure can be brought to bear on them from the outside. As the torch is passed from one administration to another, at a moment infused with hope and fear in roughly equal measure, we offer these ideas with a sense of possibility, if not certainty, that action may follow.

But in order to reform the system, the country has to find answers. The economy will not be truly healed until the causes are identified and the financial system is reconstructed on sound public principles. The names of key players in both parties must be identified, not for vengeance but because many of them still exercise enormous influence and hope to supervise the repair work, protecting their interests and papering over their past errors. Economic policy-makers like Robert Rubin, Lawrence Summers and their protégés arranged Wall Street for inflated profits and ruinous risk-taking and are now hovering around President Obama. We will not get to the hard truth about what went wrong and how to fix it if these people are in charge of investigating themselves.

In the early 1930s, the country had the Pecora hearings and sensational disclosures that stunned Wall Street and public opinion. Formed by the Senate, the commission of inquiry went through three chief counsels before it found one person tough enough to stand up to the titans of banking—an assistant district attorney from New York City named Ferdinand Pecora. His investigators pored over the books of famous Wall Street firms; then Pecora personally grilled the self-righteous bankers. Among many revelations, the commission found that J. P. Morgan Jr. and twenty partners of his firm had paid no income taxes in 1931 or 1932 and only trivial amounts before that. “If the laws are faulty, it is not my problem,” Morgan testified.

The Morgan bankers maintained lists of “preferred clients,” who were invited to participate in their speculative stock-market schemes. The list of insiders included public figures like FDR’s first Treasury secretary. Hoping to discredit the “circus” atmosphere of the hearings, Morgan’s men brought with them a person with dwarfism, who sat on Morgan’s lap. Their PR stunt backfired. The nation was convulsed in derisive laughter. The securities regulations enacted by the New Deal were grounded in what Pecora revealed.

Our crisis might not get a Pecora investigation, not one that digs out the whole truth, for this reason: This time, the dirty details of who rigged what involve many incumbent politicians, Democrats and Republicans alike, and the deals they worked out with their financial patrons on Wall Street. A close accounting would reveal how both parties collaborated for more than two decades in repealing or gutting the prudent safeguards put in place by the New Deal reformers. Congress still has some bulldog investigators, like Representatives Henry Waxman and John Conyers, but their colleagues will have very little appetite for “naming names” or exploring the money connections between Washington and Wall Street.

To dig out the answers, we must rely on the next best thing—a vigilant free press and tough-minded reporting. If that sounds improbable, some elements of major media are already on the case (perhaps seeking redemption for the Fourth Estate’s utter failure during the run-up to war in Iraq). For example, Peter Goodman of the New York Times produced a devastating account of how the Federal Reserve and the Clinton administration collaborated to block efforts to regulate the credit derivatives that became a critical factor in inducing the present crisis.

Goodman patiently reconstructed how the Commodity Futures Trading Commission’s (CFTC) efforts to impose regulatory oversight on derivatives were stymied by Fed chair Alan Greenspan, Treasury Secretary Robert Rubin and SEC chair Arthur Levitt in 1997. Greenspan, Rubin and Levitt very publicly kneecapped commission chair Brooksley Born and effectively drove her from government. They staged a brutal dressing-down and urged Congress to prevent her from acting. Congress complied with a law blocking CFTC action. Lawrence Summers, Rubin’s deputy at Treasury and later secretary himself, personally rebuked Born and accused her of threatening a financial crisis.

The opposite proved to be true. By not applying timely regulation, Washington set up the country for the disaster that followed. Given a free hand and virtually no oversight, major banks and investment houses became the leading salespeople for the dubious derivatives, assuring clients these devices protected them against risk on mortgage securities and other high-flying investments. Instead, the derivative contracts became a multitrillion-dollar time bomb threatening the banks themselves.

The history of purposeful rigging includes at least six other pivotal changes that slyly dismantled the old banking system and created a debt casino with extraordinary gambling and outrageous profits. Reporters, for instance, might look into the initial deregulation of banking—enacted by the Democratic Congress and president in 1980—when interest-rate ceilings were repealed and the sin of usury was decriminalized, authorizing the predatory lending and sky-high rates that are now commonplace. Another bipartisan project worth investigating was ably assisted by the Federal Reserve—the repeal, in 1999, of the New Deal’s Glass-Steagall Act by the Gramm-Leach-Bliley Act. The latter measure allowed the merger of closely regulated commercial banks with unregulated investment houses and opened numerous trapdoors and escape hatches for bankers to game the differences between the two.

At the time, leading newspapers led cheers for this stuff, but even the New York Times editorial page is revising its views. The press lacks subpoena power, but the Times financial and business section is a bright, shining beacon for tough reporting, with a dozen or more deeply informed and aggressive reporters, who, led by Gretchen Morgenson, are destroying the old myths of deregulation and Wall Street rectitude. (The Times also has a stable of cheerleaders who keep promoting the official happy talk.)

Greenspan, under grilling from Representative Waxman, offered a weasel-worded admission that he had been mistaken about derivatives. Otherwise, none of these guys have acknowledged error, much less apologized to the American people.

Right now, national politics is in the midst of a deep power struggle over who controls the path of reform and recovery. The old order understands viscerally that its domination is threatened, and financial titans in the shrinking Wall Street club are attempting to preempt opposition. The bail-out action so far, with hundreds of billions devoted to preserving what’s left of the status quo, suggests they are succeeding. But events are not cooperating, and a deepening recession will keep raising the question: What did the public get for all its money? Bush and Paulson will be gone, but President Obama will have to answer that question.

As president, Barack Obama inherits the awkward straddle the Democratic Party has maintained for many years—trying to serve the financial sector and its interests on one side while satisfying (or appeasing) popular constituencies like labor on the other. But Obama will have to manage this balancing act in much tougher circumstances—an economic contraction swiftly turning darker. As a candidate, he has mostly surrounded himself with Clinton-era economic policy-makers and people implicated in “reforms” that led to financial breakdown. This has caused considerable despair in some left-liberal quarters over the possibility that Obama will repeat the abrupt about-face of Clinton’s first administration, when Clinton dumped his “putting people first” campaign rhetoric and governed instead as an ally of multinational finance and business.

The despair is premature. It grossly underestimates the high skills and distinctive nerve of this very astute politician. Given his Harvard background and cautious manner of calculating positions, Obama is at home among centrist, establishment figures. As an African-American man and a junior senator running for president, Obama needed their respectability and courted them. When he takes office in January, he will be governing in very different circumstances and will have to decide if his presidency can subsist on cautious, small-bore reforms or must govern with a far more ambitious conception of what the country needs. Things are changing rapidly, and none of us know how it will turn out. Obama probably doesn’t, either.

A photo op Obama arranged with his economic advisers a few weeks before the election tells the story. Arrayed on either side were policy leaders from the old order. Former Federal Reserve chair Paul Volcker collaborated in the initial deregulation of banking in 1980 and presided over the initial bail-outs of banks deemed “too big to fail.” Robert Rubin was the architect of Clinton’s center-right economic strategy and is now senior counselor at Citigroup, itself endangered and the recipient of $25 billion in public aid. Lawrence Summers, disgraced as president of Harvard, is now managing partner of D. E. Shaw, a $39 billion private-equity firm and hedge fund that specializes in esoteric mathematical investing strategies. Laura Tyson was chair of Clinton’s Council of Economic Advisors and is now a University of California-Berkeley professor who sits on the boards of Morgan Stanley, AT&T and KPMG, the global accounting giant.

None of these people are well equipped to lead fundamental reform of the system they helped create or to speak reliably for the broader interests of society. Volcker, now 81, was a brilliant Fed chair who subdued runaway inflation, but he was no friend of working people. His hard-nosed monetary policy smashed wages, even as he managed the rescue of major banks in the Third World debt crisis, replacing their exposure with public lending from the I.M.F. and World Bank. Rubin is preoccupied with saving his bank from ruin, but Obama’s staff is loaded with Rubin acolytes. Nine months ago, Rubin dismissed this crisis as a cyclical hiccup. Summers, on the other hand, seems to be actively running for Treasury secretary or maybe Fed chair. His public pronouncements are taking on a softer edge, and he has dropped his Calvinist devotion to balanced budgets. But now that he works for a celebrated hedge fund and private-equity firm, where does Summers stand on regulating these creatures?

Informed gossip says other leading candidates for Treasury secretary are New York Fed president Timothy Geithner, a Rubin protégé; New Jersey Governor Jon Corzine, a former Rubin colleague at Goldman Sachs; and Jamie Dimon, CEO of JPMORGAN Chase, the bank with the largest vulnerability on dangerous derivatives. Corzine is the only one with a strong record of social concerns. Another long shot is Sheila Bair, a Republican regulator and chair of the FDIC; her aggressive corrective actions have angered some big-name bankers.

Finding a financier without severely conflicting personal interests and with experience enough to manage the massive bail-out will be difficult, no matter who would have won the White House. And standing too close to the old order does not seem very promising. Given this country’s deformities of power, the president usually needs the establishment’s help to prevail or at least avoid open warfare on important matters. Given the extreme circumstances Obama will inherit, he may face a very different calculation. If the old financial order is at the heart of the economic problem, would the president be better off protecting it or trying to disturb its power and cut its institutions down to size? For the first time in many decades, it may be smarter politics to confront the “economic royalties” (as FDR called them in the 1930s) and force major reforms of their behavior. Does Obama have the guts for such a dramatic confrontation? We don’t yet know. But we do know it took a lot of nerve for a young African-American man with a different vision of the country to run for president when the reigning elders told him it was not his turn.

The established order, meanwhile, is setting out some “opportunities” for the next president to demonstrate that he is a high-minded, responsible leader. These are really traps that could doom his presidency. Military leaders are insisting on larger Pentagon budgets after withdrawal from Iraq—preempting the social spending that people have been promised. Financial leaders are urging that greater powers be given to the Fed despite the failures of that cloistered institution. This would be a great victory for the Wall Street club, cementing the privileged powers of the corporate state the bail-outs seem to have created. The so-called responsibles are likewise proposing “reform” that will cut benefits for entitlement programs, especially Social Security, as a way to correct the nation’s budget deficit. This would constitute another historic swindle of the people—much larger than the bank bail-out.

President Obama would probably gain favor with the public if he rejected all three of these propositions. He would be bolstered further if the people found their voice. This expression can take the form of direct actions, large or small, nonviolent civil disobedience that pushes the new president further than he perhaps intends to go. People can reshape public opinion by showing other citizens they have the power to stop foreclosures in their neighborhood or rally the jobless to demand public employment for all or surround the rescued banks with thousands of their new public “investors,” demanding lower credit-card interest rates or relaxed terms for failing mortgages.

The financial crisis continues to spread upheaval in many directions, and we do not yet know how wide or deep the destruction will flow. But strange and sometimes wonderful surprises can happen in unsettled circumstances. In the crisis of the Great Depression, a Mormon Republican banker from Utah showed up in Washington, pushing his heretical understanding of the crisis. Marriner Eccles never graduated from college, but he figured out from his banking experiences the basic economic principles the nation should follow (which later became known as Keynesian economics). Eccles was desperate to share his insights. In February 1933, he managed to testify before the Senate Finance Committee. In one sitting, he laid out an agenda that encompassed nearly all of the important measures the New Deal subsequently enacted. The left-wing advisers around Roosevelt recognized a kindred spirit, and Eccles was asked to join the White House staff. He drafted the 1935 reform legislation that created the modern Federal Reserve. Then FDR appointed him as Fed chair.

Maybe in our chaotic circumstances, there will be similar odd convergences. One hopes our new president will be open to them—willing to listen to fresh thinking from outside the circle of established opinion-makers and brave enough to act on new ideas. Barack Obama will need all the help he can get.